Deconstructing the contractor compensation debate

Agencies have reimbursed contractors for their executive salaries in one form or another since a 1997 law enabled it, a practice that seems reasonable to some and objectionable to others.

While there is a debate over whether government should do it at all, perhaps the more pressing issue is at what level the reimbursements should be capped.

"We're near the boiling point," said Trey Hodgkins, senior vice president of global public policy at TechAmerica.

The cap, calculated based on a formula first devised by the Clinton administration's Office of Federal Procurement Policy, was $693,000 in 2010 and rose to $763,029 in 2011. According to current OFPP administrator Joe Jordan, the cap will next have to be bumped to $950,000 if no legislative action is taken.

The struggle over current federal contractor reimbursement levels has its roots in 1997's Internet-fueled economy. At the time, now-retired Sen. Joe Lieberman, (I-Conn.) and others in government were concerned that top executive talent at private companies, immersed in the white-hot, high-tech-driven environment of the time, would eschew government contracts in favor of more lucrative private industry work. The idea was to sweeten the pot for contractors, adding funds to cover some or all of their executive salaries. It applies only to cost-reimbursement contracts.

Under the formula, the cap is based on the salaries of top corporate executives. Over the years, Congress has tried repeatedly to rein in the payments as the U.S. economy has slowed and CEO compensation has skyrocketed. In 2011 and 2012, Sen. Charles Grassley (R-Iowa), Sen. Barbara Boxer (D-Calif.) and other lawmakers unsuccessfully tried to reduce the cap.

More recently, bills have attempted to make the cap equal the salary of the president ($400,000) or the vice president ($273,000). This time around, private- and public-sector economic conditions could force lasting change. In the last decade or so, the gap between executive and regular employee pay at contracting companies has widened into a chasm. According to an AFL-CIO study in April, chief executives of the nation's largest companies earned an average of $12.3 million in total pay last year -- 354 times more than a typical American worker. Those executive payment levels, say opponents of higher caps, are prohibitive for taxpayer reimbursements for contractor executives.

This year, federal agencies have been thumped by sequestration cuts, with some instituting furloughs for employees to save money and all looking to substantially reduce costs and increase efficiency.

Step by Step

A look at how the contractor compensation cap has risen in recent years, in thousands of dollars, as reported by the Office of Management and Budget. Click here for detailed data.

"The trouble began when the reimbursement level was tied to executive compensation," said Scott Amey, general counsel at the Project on Government Oversight. Amey, other government watchdog groups and lawmakers in favor of limiting reimbursement contend the payments are incongruent in a government tightening its belt and a stumbling national economy.

Calculating the Cash

The contractor compensation rules are slightly different for civilian contractors and defense, according to Scott Amey, general counsel at the Project On Government Oversight.

For civilian contractors, the five highest-paid executives in the company are eligible for compensation. For defense contractors, as of 2011, it applies to all DOD contract employees, not just executives.

The formula for calculating the cap is complicated, but boils down to this:

Using commercially-available surveys, determine the median amount of compensation provided for all senior executives, using data from the most recent year available when the OFPP administrator determines the amount.

The data used is the total amount of wages, salary, bonuses and deferred compensation earned by the five highest paid employees in management positions in publicly traded U.S. companies with annual sales of more than $50 million.

Once OFPP establishes the benchmark compensation amount, it stays in effect until OFPP again revises it.

"The payments place a huge burden on taxpayers. We need reform," said Amey. "Why does CEO pay apply to a defense contractor when there are hiring freezes and pay freezes at government agencies?"

Amey said that, ideally, he'd like a new reimbursement cap set at $200,000, with individual waivers filed if more money is needed to keep a top-level executive on the job.

Groups that represent federal contractors contend the picture is more nuanced, arguing they well understand the pressure to cut costs, but also see private industry continually drawing valuable executives away from government contract work. They say there must be realistic compensation to keep talented contracting-company executives engaged, especially in some critical markets. They also said they are open to other solutions. But if reimbursement is unrealistically limited and executives seek more-lucrative private industry work, said Hodgkins, "we stand to lose skills and erode our ability to retain top performers in key areas like cybersecurity and software design."

One way to address the ballooning executive reimbursement caps, he said, is to change the baseline of payments. Instead of tying them to the top five executives' salaries, they should be based on broader compensation data gathered by the Department of Labor. "We should use a formula based on public sector averages, and shouldn't conflate salary with compensation," he said.

Salary and compensation are not the same thing, Hodgkins stressed. The president, he argued, receives benefits beyond his salary, so using only the salary isn't the most accurate yardstick.

Steve Kelman

Some who have watched the battle over the years are conflicted about the process and its results, but ultimately see reimbursement caps as a roadblock to government contracting.

"I can see the arguments from both sides," said Steve Kelman, professor of public management at Harvard University's Kennedy School of Government and former administrator of the Office of Federal Procurement Policy. Savings are vital to government, he noted, yet government also needs top talent working on some of its most difficult problems.

Ultimately Kelman argued that reform should affect all executives, not just those working on government contracts. "I come down on the side of 'if you want to address pay inequality, do it through tax law and don't single out government contractors,'" he said. "That deters companies from doing business with the federal government."

Reform efforts

Multiple proposals looking to reshape the reimbursement payments have been introduced in Congress in the last few months. Last year, legislation to reform the caps stalled.

Recently, OFPP administrator Joe Jordan recommended tying the caps to the president's $400,000 annual salary and extending them beyond only defense contractors and the top five nondefense contractor executives.

On June 20, the 2013 Commonsense Contractor Compensation Act was introduced by Rep. Paul Tonko (D-N.Y) and Sens. Barbara Boxer (D-Calif.), Chuck Grassley (R-Iowa) and Joe Manchin (D-W.Va.). The legislation would cap the maximum salary reimbursement for all government contractors at the vice president's $230,700 annual salary, and extend the cap to cover all defense and civilian contractor employees.

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Reader comments

Tue, Aug 6, 2013
John Inman
Williston, Vermont

Government contractors already deal with unallowable costs every day -- and they continue to incur those costs, such as booze for the company picnic, but they simply don't include those costs in their direct or indirect cost pools for Government contracts. It's the same with executive compensation -- even with the current caps, some companies still pay more to certain executives -- but they don't include the overages in the Government contract accounting. This isn't a big deal.

Thu, Jul 11, 2013

What if a critical contractor does not feel the defense of our nation is as important as the govt does and therefore does not pay to reatin a critical executive? In this case a program the govt feels is vitally important will then totally depend on whether or not the contractor feels the same way. If they don't they will let the exec go to more lucrative work while national defense (as determined by the govt) languish. So here, the taxpayer (represented by the govt) wants a program badly. The contractor disagrees and the taxpayer does not get what he/she wants. Who's fault will that be? Hint: the govt.

Tue, Jul 9, 2013
OccupyIT

This is a Red Herring for the simple minded. Demagogues can make hay with this issue but my guess is they have already spent more money beating the war drums about this than it has actually cost the Government in real dollars. The average officer of a contracting firm doesn't make anywhere near that ceiling and since the cost is spread over all their contracts I don't think it adds up to much in real terms. It is an apple-pie issue designed to stir up us-them friction. Unnecessary and unproductive. Get back to mission folks! Get rid of bad contractors and reward good contractors - next!

Mon, Jul 8, 2013

How can this be a democratic goverment when we have corupt policies like this giving top executives money so they can keep doing business with the goverment. We are no better then the next guy down the road. You know you get paid for the work you do and if you do not do it then that is it, go some where else to get that money. We should stop this giving away of money, some of this top executive would not make it with all this hand outs we are giving them. You would have some of the small companies be able to compete if they would stop giving away money to this Corporations that do not put out quality equipment. Think of the billions of dollars they would save if they would quit giving this top executives money. Someone's is in somebody's back pocket, think about it.

Wed, Jul 3, 2013
Scott Amey

Our colleagues at the Center for Effective Government have been out front arguing that the the cap applies to fixed-price contracts, stating that “whenever Federal Acquisition Regulation cost principles apply to the pricing of a contract [i.e. when cost analysis is used pursuant to FAR 31.102], the caps should apply.”
Additionally, we have to remember that the cap doesn’t limit how much contractors compensate their employees, it only limits how much of that compensation the taxpayers have to pay. We need to remove the burden of exorbitant salaries from the taxpayers' shoulders.

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